A Look At Sears Canada's Net Asset Value

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About: Sears Canada Inc. (SRSC), SRSCQ, Includes: SHLDQ, TGT
by: Elephant Analytics
Summary

Based on Target Canada's lease and property sale, Sears Canada may have around $253 million USD in net real estate value remaining.

Sears Canada has sold off its best properties over the last few years, and Target Canada's failure has brought lease values down to earth.

Any real estate value calculation using pre-2015 numbers is very outdated.

Sears Canada may retain some positive net asset value currently, but will likely eat that up if it stays in operation.

Even a 10% improvement in EBITDA as a percentage of revenues will leave Sears Canada with no net asset value by the end of 2018.

Sears Canada (SRSC)(OTCPK:SRSCQ) appears to have some net positive asset value remaining, although this will be quickly eaten up if Sears Canada remains in business beyond 2017. Given the scale of Sears Canada's retail losses, I have little confidence that it will be able to eliminate its cash burn, even after closing a substantial number of stores. A bet on Sears Canada's equity at this point is really a speculation that it will need to close down operations this year, thus possibly preserving positive net asset value.

The exchange rate used in this article is $1.25 CAD to $1.00 USD.

Valuing The Retail Space

Sears Canada is said to have around 15 million square feet of retail space, which is similar to the reported 14.5 million square feet for Target (NYSE:TGT) Canada. The overall quality of Sears Canada's locations is fairly similar to that of Target Canada's as well. Sears Canada previously had 16 locations in the top 25 Canadian malls, but has sold many of its best locations over the last few years. By the time I checked on Sears Canada a couple years ago, it was down to seven locations in the top 25 Canadian malls, compared to Target Canada's nine locations in the top 25 Canadian malls.

After Target Canada filed for bankruptcy, it solicited offers for its leases and its owned real estate (mostly distribution centers). It appears that Target Canada received approximately $570 million CAD ($456 million USD) from the sale of its various properties and leases. This includes around $256 million CAD ($205 million USD) for three owned distribution centers though, bringing the total consideration for leased stores (and at least one owned store that it sold) down to approximately $314 million CAD ($251 million USD).

The $314 million CAD ($251 million USD) would probably serve as a reasonable approximation of the value of Sears Canada's leases, although it is probably also on the high side given the relative shape of the stores. Target Canada spent a large amount of money updating and upgrading its stores, while Sears Canada has been thrifty with capital expenditures.

As well, Target Canada ended up settling various landlord claims for approximately $180 million CAD ($135 million USD), so the net consideration of its leased stores ended up around $134 million CAD ($107 million USD). A previous estimate of Sears Canada's remaining owned real estate put its value at $182 million CAD ($146 million USD), so the combined owned plus leased real estate might be worth $316 million CAD ($253 million USD), net of landlord claims. The landlord claims would be treated as unsecured claims that would rank ahead of the equity.

Total Asset Value

At the end of Q1 2017 Sears Canada had $164 million CAD ($131 million USD) in cash and $658 million CAD ($526 million USD) in inventory. Adding receivables and the net real estate value calculated above would put Sears Canada's asset value at approximately $1.212 billion CAD ($970 million USD). Subtracting payables, long-term debt, retirement liabilities and provisions would brings this down to $403 million CAD ($322 million USD). The largest component of provisions is severance, which Sears Canada may avoid paying for now.

However, as accrued severance would now be treated as an unsecured claim, it still has relevance to whether there is any value remaining for the equity.

Please note that the following table involves estimates to get a ballpark idea of Sears Canada's net asset value.

$ Million CAD

$ Million USD

Cash

$164

$131

Receivables

$74

$59

Inventory

$658

$526

Net Real Estate

$316

$253

Payables

-$338

-$270

Long-Term Debt

-$120

-$96

Retirement Benefit Liability

-$295

-$236

Provisions

-$56

-$45

Change in Cash

-$100

-$80

Net Asset Value At Filing

$303

$242

Since the end of Q1 2017, Sears Canada has also had substantial cash burn. It reported cash burn of around $20 million CAD ($16 million USD) per week in May. I have assumed that Sears Canada ended up burning around $100 million CAD ($80 million USD) from the end of Q1 2017 to when it filed for creditor protection. I've used a burn rate lower than $20 million CAD ($16 million USD) per week for that whole period since it appears that May's cash burn was probably increased by working capital effects.

Subtracting $100 million CAD ($80 million USD) would bring Sears Canada's net asset value down to $303 million CAD ($242 million USD). Assuming $75 million CAD ($60 million USD) in operational cash burn by the end of creditor protection (before working capital changes) and the $37 million CAD ($30 million USD) in estimated capital expenditures, DIP interest costs and professional fees outlined in the cash flow projections would result in Sears Canada's net asset value decreasing to $200 million CAD ($160 million USD). There are also store closing costs, which could bring Sears Canada's net asset value down to around $160 million CAD or $128 million USD ($1.57 CAD or $1.25 USD per share).

Retail Losses Will Continue To Eat Up Value

If Sears Canada decided to close down all its operations and liquidate everything in 2017, I could see it having some positive net asset value left over for the equity. However, it appears that Sears Canada is going to attempt to continue operating into 2018 with a smaller footprint. This strategy has a very high chance of consuming the remaining positive net asset value.

Given its relative size, Sears Canada is in worse shape than Sears Holdings (SHLD). I estimated that Sears Canada was on track to deliver negative $400 million CAD EBITDA ($320 million USD) in 2017, roughly 40% of Sears Holdings' negative EBITDA level. However, Sears Canada is roughly 10% of the size of Sears Holdings.

Thus an exceptional amount of improvement would be needed for Sears Canada to staunch its cash burn. Sears Holdings hasn't really improved its EBITDA over the last few years despite significant amounts of job cuts and store closures. While Sears Canada is closing an even larger percentage of stores, even a marked improvement in EBITDA (such as cutting its negative EBITDA run rate by over 50%) would still result in it having negative net asset value by the end of 2018. The publicity surrounding Sears Canada's severance pay and pension issues probably won't help it either.

Conclusion

Sears Canada appears to potentially have some net asset value left if it completely closes down operations in 2017. However, it appears to be planning to continue operations with a reduced number of stores, and it is very likely that doing so will result in the remainder of its net asset value being eaten up by continued losses next year. Sears Canada's current performance is poor enough that even improving its EBITDA margin (as a percentage of revenues) by 10% likely won't be enough to keep its net asset value dwindling below zero next year. I think the only reason to potentially own Sears Canada's stock is as a speculation that it won't attempt to continue operations beyond this year.

While Sears Canada does potentially have a few hundred million in real estate assets remaining, its crown jewel properties have been sold off. Some have speculated that Sears Holdings might try to purchase some of Sears Canada's assets, but I don't see much value in Sears Holdings trying to do that. Landlords and other retailers would probably bid enough for the better remaining properties that the buyer wouldn't end up with significant excess value. Given Sears Holdings' continual need to generate liquidity, using capital to purchase Canadian assets at around market value doesn't seem like a great use of its liquidity.

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